What Credit Score Do I Need for a Car Loan? | The Motley Fool (2024)

What is a good credit score for a car loan?

A FICO® credit score above 670 is generally considered "good," although there isn't a set definition of what good credit is. Different lenders have their own credit standards. FICO credit scores are the industry standard and are used by more than 90% of lenders when making decisions.

The FICO® Score is computed based on factors including the borrower's payment history, amounts owed on loans and credit accounts, the length of their credit history, and more. It is expressed on a scale ranging from 300 to 850, with higher scores being better.

What is your credit score?

One smart thing to do before you begin the car loan process is to check your own credit score. Be sure you're looking at a FICO® Score, as that's what the lender(s) you apply to are most likely to use.

Many credit card issuers give customers a free FICO® Score as a perk of membership, but it can be a smart idea to pay for a score-monitoring service. I use myFICO.com, as it's run by the creators of the FICO® Score. Not only does this get you access to FICO® Scores from all three major credit bureaus, but there are many other useful tools as well (like auto-specific FICO scoring models that auto lenders are likely to use).

How credit scores affect the cost of a car loan

Just because you can get an auto loan with a low credit score doesn't mean that it's always a good financial move to do so. Whether or not it's a good decision depends on your unique situation.

For starters, lenders tend to offer significantly higher interest rates to subprime and deep-subprime borrowers. This can make a car far more expensive than its sticker price might lead you to believe. Here's a look at the national average auto loan APRs as of August 2023:

Here's what this means to you.

Let's say that you want to buy a new car. You want to obtain a $30,000 loan with a 60-month term to do it.

In this example:

• If you have a FICO® Score of 720 or higher:
  You will likely pay a $600 monthly payment.
  That's $5,992 in interest over a 60-month car loan.
• If you have a 675 FICO® Score:
  Your payment would likely be about $640.
  That's $8,392 in interest alone over the life of the loan -- you'd pay about $2,400 more in interest than a top-tier borrower.
• If your FICO® Score is 600:
  You'd probably pay $738 per month.
  That's $14,280 in total interest -- for the exact same car.

In this case, the difference between fair and good credit scores could literally mean more than $8,000 in additional interest.

Getting a car loan with a low credit score

To be clear, you can get a car loan with a low credit score. Although the subprime mortgage market has virtually disappeared since the financial crisis about a decade ago, the subprime auto loan market is alive and well. The recent spike in interest rates and economic uncertainty has made many lenders reduce their subprime lending, but it's still a big part of the auto lending industry.

While the exact definitions of these terms vary depending on who you ask, the Consumer Financial Protection Bureau, or CFPB, defines subprime as borrowers with credit scores of below 620 and deep subprime as borrowers with scores below 580.

Beware of these 4 car loan mistakes

Regardless of whether you have excellent credit, terrible credit, or you're somewhere in between, there are a few potentially costly mistakes that are important to avoid.

Long-term loans

While the industry standard used to be 48- and 60-month loan options, 72-month and longer terms are now common. I've even seen 96-month (eight-year) loan terms. Auto dealers use these long terms to lower monthly payments and allow buyers to qualify for more expensive vehicles.

The problem: Stretching a loan out can dramatically increase your interest cost. For example, a $30,000 car loan at 8% interest for 60 months will cost you $6,498 in total interest. The same size loan with the same interest rate for 84 months would cost $9,277 in interest. Long-term loans are helpful for borrowers who can't afford the monthly payments of a short-term loan on a vehicle they need -- but a long-term loan shouldn't be your first choice.

The "monthly payment trap"

Car salespeople like to ask you how much you're looking to spend per month. Under no circ*mstances should you answer this question. This effectively gives them permission to charge you as much as they want in interest (and for the car itself), as long as the monthly payment is within your limit. The price of the vehicle, price of your trade-in, and the interest rate on your loan should be three separate negotiations.

Rolling your existing car loan into your new one

You may see advertisem*nts that say something like "we'll pay off your trade, no matter how much you owe." Well, if the value of your trade is less than the amount you owe (known as a negative equity situation), many finance companies will add the difference to your new car loan. This is how people end up with a $35,000 loan for a $30,000 car -- avoid this type of situation at all costs.

Overpriced add-ons

Salespeople, especially in the finance department, love to try and upsell you on these. When I bought a 2013 Chevy Camaro about a decade ago, the dealership's finance manager offered to sell me an upholstery treatment for $12 per month added to my loan's payment -- that's a total of $720 on a 60-month loan. I said no, only to learn that it had already been installed in the car, and they were going to give it to me whether I paid for it or not. Needless to say, I'll never do business with that dealership again.

Perhaps the most important suggestion I can give you, especially if you have so-so credit, is to shop around for your next car loan. You may be surprised at the dramatic difference in offers you get.

Many people make the mistake of accepting the first loan offer they get (usually from the dealership). It's a smart idea to get a pre-approval from your bank as well as from a couple of other lenders. Online lenders and credit unions tend to be excellent sources for low-cost loan options. Not only are you likely to find the cheapest rate this way, but you'll then have a pre-approval letter to take to the dealership with you.

The best part is that applying for a few auto loans won't hurt your credit. The FICO credit scoring formula specifically allows for rate shopping. All inquiries for an auto loan or mortgage that occur within a 45-day period are treated as a single inquiry for scoring purposes. In other words, whether you apply for one car loan or 10, it will have the exact same impact on your credit score.

Buy a car now or work on your credit?

The bottom line is that there is no set minimum FICO® Score to get a car loan. There's actually a good chance that you can get approved for an auto loan no matter how bad your credit is.

Having said that, subprime and deep-subprime auto loans can be extremely expensive, so just because you can get a car loan with bad credit doesn't necessarily mean you should. The savings from a moderate score increase can be substantial, so it could be a smarter idea to wait for a bit and work on rebuilding your credit before buying your next car.

Still have questions?

Here are some other questions we've answered:

• What is a good credit score for a personal loan?
• How much personal loan can I get?
• How do I apply for a personal loan?